Changing FBR head is easier for PM Imran than fixing FBR? Part – I

A couple of months before the PM fired the FBR Chairman, he had threatened his own machinery, which collects more than 96% of the Federal Revenue with disbandment and replacement. The wizard of Kaptanistan with apology to Late Bhutto was screaming “So what, if the FBR fails in collecting revenues, so what if the whole of FBR fails, we will build a new FBR, we will build a bigger FBR, we will build a stronger FBR, we will build a better FBR” as if by waving a magic band and creating a NAYA FBR, rivers of milk and honey will flow along the NAYA Poultry farms.

Notwithstanding the removal of its Head, the department still proudly stands on its pillar and a new economic team has been constituted in Finance, SBP and FBR headed by as many allege by IMF. No details have been provided as to how the change of head will improve the current structure of FBR and how the new structure will achieve the targets whereas the previous model failed? The PM has ignored the fact that FBR is but just one component of the Juggernaut and other factors like narrow tax bases, tax exemptions, informal economy, underreporting of formal income and culture of no taxation without representation will have to be addressed as well and that the PM will have to look beyond the failure and corruption of FBR.

That does not mean that FBR does not need any re-organisation or a fresh approach. Yes, it does. However, it will become an effective organisation when and only when the Government itself puts its house in order, make bold legislation and reforms in the interest of the nation rather than that of the vested interests and rent seekers. This paper attempts to (1) Analyse the fault lines in Revenue base of Pakistan (2) How to increase the revenue and (3) Examine how FBR can be improved.

Pakistan like any emerging country suffers from a low revenue but fares relatively badly with most emerging country. Out tax to GDP ratio hovers in the range of 9% to 12%, which is quite low compared to the desired ratio of 20% required for an emerging economy or 15% average of developing countries. The countries with a lower ratio to Pakistan are generally the LCDs and oil producing countries who do not tax their citizens. Most professional studies including by IMF puts Pakistan revenue potential at 23%, the revenue gap of 11% being significant but do-able. This virtually means doubling the revenue in the first instance which mercifully is quite do-able if political will is there. The one reason that Mr. Imran Khan is the PM because the people believe he has the political will to make bold decisions. If he does not use that will, Pakistan’s tax effort (collection vs potential) 0.46% compared to emerging economies average of 0.64 & and high-income country ratio of 0.76 will not increase, no matter how many departments are re-named.

Pakistan’s traditional strategy at tax mobilization has always been to further burden the compliant taxpayers or increases taxes deducted at source rather than broadening the tax net for which both the Cabinet and Parliament colludes and it is but natural for FBR bureaucrats to do the same. Agriculture and Services Sector forms 80% of the GDP and tax from these sectors is miniscule. The Agriculture sector accounts for 20% of GDP and 45% of Labour Force but its contribution to tax revenues is less than 0.1% (devolved to provinces in NFC award) The revenue contribution comes mainly from the over-burdened Industrial sector and payers of withholding tax and GST. The Parliament is dominated by agriculturists who have resisted income tax on agriculture, ironically citing heavy losses, forgetting that no income tax has to be paid for any losses including losses in the agriculture sector. Now the agriculturists cum industrialists have a field day by mis declaring their industrial income as agriculture income thereby lessening their industrial taxes also. It would have been beyond comprehension that FBR allows so much agricultural income to go tax free on the plea that agriculture is non profitable enterprise in Pakistan were it not for the truth that the Cabinet and Parliament colludes in this. Agriculture of course is not the only culprit. The situation is bad on all fronts as the tax machinery is plagued with exemptions and marrow base.

The number of companies registered for Corporate Income Tax is less than 28,000 against estimated 70,000 companies and these registered companies account for less than 1% of electricity consumed, hinting towards a large informal economy operating outside the tax net

The Budget requires FBR to collect Rs 4435 billion in 2018-19 with 40% coming from Direct taxes and 60% from Indirect Taxes, From the Direct Taxes, the large bulk, almost 50% will come from Withholding Tax (WHT) on contracts, salaries, import, utility bills bank transactions etc. GST has become the dominant source of revenue, accounting for around 50% in Indirect Tax, other being Customs Duty and Federal excise, In other words, over half of all FBR revenues comes from just GST and WHT. Lets us see these individually in terms of IT and GST first.

In a nation of 210 million, less than 0.5% of the population or 1% of the adult population pay income tax compared to over 2.5% in India, 20% in China and over 40% in Australia. The PM lamented “How can it be that of the 210m Pakistanis only 72,000 declare monthly incomes of Rs200,000 or more?” In reality, around 1 million persons only pay IT against an estimated 5.6 million with earnings above the taxable threshold. Such a low number reflects the weakness of FBR as well as the collusion of the Parliament to keep the agriculture sector out of the tax net.

More startling that individual tax payers is the case of business and companies. The number of entities registered for GST is less than 180,000 in a country which has more 1.5 million retailers and 3.5 million commercial and industrial electricity users. This is the nightmare that the Government needs to focus on. Within the GST regime only 2 sectors traditionally accounted for 50% of the GST, namely the Petroleum and Telecommunication sector, the burden falling equally on the poor and rich, rather than proportionately. Too many exemptions and “leniencies” are given in the GST domain, including in not tapping main industrial sources, the huge wholesale and retail sector, the professional sectors, letting even the GST registered with no returns filed and fraud and collusion in sales tax refund and so-called “Flying Invoices”. Genuine exporters also suffer due to delayed sales tax refund in an economy with very high interest rates.

As far as weakness in collection of Custom duties and excise goes, it is well entrenched in the national psyche as a symbol of the corrupt Custom officials.

The number of companies registered for Corporate Income Tax is less than 28,000 against estimated 70,000 companies and these registered companies account for less than 1% of electricity consumed, hinting towards a large informal economy operating outside the tax net.

All of the above weakness and narrow tax base leads to operation of informal economy. The estimation of black economy and resultant tax evasion is a complex process but nonetheless calculated by some acceptable criterion using direct and indirect methods including complex formulas, monetary aspects, linking with electricity consumption and other criteria. Studies by PIDE (2003) and State Bank of Pakistan (2010) applying various methods shows the same trend though the share of black economy ratio differs by ten percentage points at the peak of black money which was Nawaz Sharif period before his Government was toppled by a military coup. Since then, in Musharraf period, black economy and tax evasion continued to reduce and rose again in civilian rules. The highest share of black economy estimated by PIDE was in 1998 at 54.5% of GDP and 7.2% of GDP tax evasion. SBP also estimated the peak in 1998 at 37% of the GDP. During the post Musharraf period, it is assumed to be higher though no formal study has been undertaken to estimate the tax evasion. All of these challenges are actually opportunities in waiting and indicate what must be done.